Module 2

Introduction
• Determining the total value of a company involves more than
reviewing assets and revenue figures.
• Investors who are considering multiple investments may request
equity valuation of a company, to make the most informed
investment decision.
• Valuation methods based on the equity of a company include a
thorough analysis of the cash accounts, forecasts of future
dividends, future earnings and the distribution of dividends.
• A thorough analysis of the tangible and intangible assets allows
prospective investors, shareholders and financial managers of a
company to obtain critical performance data about the company’s
business operations. 2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

1) Book value: Concepts of Value
• To clearly distinguish the market price of share from shareholder’s
equity the term “book value” is often used
• since it focuses on the values that have been added and
subtracted in the accounting books of a business.
• It is a valuation metric that sets the floor for stock prices under
worst-case scenario.
• Book Value= Net worth/ Total no. of shares Outstanding

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

2) Replacement value:
• The term replacement cost or replacement value refers to the
amount that an entity would have to pay, at the present time, to
replace any one of its assets.
• It not only includes the cost of acquiring or replicating the
property, but also all the relevant costs associated with
replacement.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

3) Liquidation value:
• The term liquidation value is the amount that the company could
realize if it sold its assets, after terminating the business.
• It is the minimum value, which a company might accept if it sold
its business.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

4) Going concern value:
• The going concern value is the amount that a company could
realize if it sold its business as an operating (still continuing)
business.
• It will always be higher than the liquidation value as it reflects the
future value of assets and value of intangibles

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

5) Market value:
• The market value of an asset or security is the current price at
which the asset or the security is being sold or bought in the
market.
• Itis expected to be higher than the book value per share for
profitable and growing firms

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

 Bond

• A Bond is a long term debt-instrument or security

• Bonds issued by the govt. do not have any risk of default
• Bonds of PSUs in India are generally secure but they are not free from the
risk of default
• The bonds issued by private sector companies in India are called as
Debentures

Dr. Shahrukh Saleem, VITBS,VIT, Vellore 2/9/2024

 Types of Bond

• Secured Bonds
• Unsecured Bonds
• Redeemable bond/ Bond with Maturity

Dr. Shahrukh Saleem, VITBS,VIT, Vellore 2/9/2024

 Features of a Bond

• Face Value/Par value

• Interest Rate/Coupon rate
• Maturity
• Redemption value
• Market Value

Dr. Shahrukh Saleem, VITBS,VIT, Vellore 2/9/2024

 Dividend Discount Model

•A difficult problem in using a dividend discount model is the

timing of cash flows from dividends.
• Hence in order to manage the problem, assumptions are made
with regard to the future growth of the dividend of the
immediately previous period available at the time the investor
wants to determine the intrinsic value- (anticipated or calculated
value of a company/stock, currency ) of his/her equity shares.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

 Assumptions

1. Dividends do not grow in future, i.e., the constant or zero growth

assumption.
2. Dividends grow at a constant rate in future, i.e., the constant
assumption.
3. Dividends grow at varying rates in the future time period, i.e.,
the multiple growth assumption.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

 The Zero-growth case

• The growth rate of dividend D at time “t” will be known by solving

for “g” in the following:
Dt= D t – 1 ( 1+ g t) 1

Or , Dt = D t – 1 ( 1+ g t) 2
D1 – 1

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

• You can easily see when g t = 0, in equation 1 will yield Dt= D t – 1
which means all the future dividends would equal to be current
dividend (ie, the dividend of the immediately preceding period
available as on date).
• Now the present value of dividends for an infinite period would
be
V= D0 D0 D0
ꝏ 3
1+K 1+K 1+K

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

• Since D0= D1 = D2= D3, under the zero grown assumption the
numerator D1 in the equation 3 is replaced D0.

V0– D0 D0
1 = 4
K K0

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

• Since D0= D1, equation 5 can also be written as,
V = D1
5
K
• This is one case for application of zero growth assumption.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

 Illustration
Consider a preference share on which the company expects to pay a
cash dividend of RKV Rs 9 per share for an indefinite future period.
The required rate of return is 10% and the current market price is Rs
80. would you buy the share at its current price?

Solution : This is a zero-growth case because the divided per share

remains Rs 9 for all future time periods.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

The intrinsic value of the share is found using the equation
V= Rs 9.00 /0.10 = Rs 90

The intrinsic value of Rs 90 is more than the market price of Rs 80.

you would consider buying the share.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

 Illustration

Assume that the dividend per share is estimated to be Rs 4.00 per

year indefinitely and the investor requires a 20% of return.

Solution: The intrinsic value of the equity share is Rs 4.00 /0.20 = Rs

20 ( This model is more appropriate for an analysis of preference
shares because of the constant dividend assumption).

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

 Constant Growth case

When dividends grow in all future periods at a uniform rate ‘g’

Dt= D t – 1 ( 1+ g ) t 1

Substituting ‘D’0 in equation (1) by the value of D1, we get

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

For a constant amount D0 can be written out of summation to
obtain the following equation

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

Constant amount, ‘D’0 can be written out of summation to obtain
the following equation

2/9/2024
Dr. Shahrukh Saleem, VITBS,VIT, Vellore
Substituting mathematical properties of infinite series, if K > g, it
can then be shown that

Which can be re written as follows:

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

 Illustration

D Ltd paid a dividend of Rs.2 per share for the year ending march
31, 1991. A constant growth of 10% income has been forecast for
an indefinite future time period. Investors required rate of return
has been estimated to 15%. You want to buy the share at a market
price quoted on July 1, 1991 in the stock market at Rs.60. what
could be your decision?

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

Solution: This is a case of a constant growth rate situation. The
intrinsic value of the equity share is calculated as follows:
V = D1
( K – g)

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

= Rs 2 (1.10)
0.15 – 0.10
= Rs 2.20
0.05
= Rs 44.00

The intrinsic value of Rs 44 is less than market price of Rs.60.

Hence, the share is overvalued and you should not buy.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

The present value of all dividends forecasts up to and including time
‘T’, VT(i) Would be

2/9/2024
Dr. Shahrukh Saleem, VITBS,VIT, Vellore
 Illustration
V Ltd paid dividends amounting to Rs 0.75 per share during the last
year. The company is to pay Rs 2 per share during the next year.
Investors forecast a dividend of Rs 3 per share in that year. At this
time, the forecast is that dividends will grow at 10% per year into an
indefinite future. Would you sell the share if the current price is Rs
54. The required rate of return is 15%.

Solution: This is a case of multiple growth. Growth rates for the first
phase must be worked out and the time between the two phases
established. It is clear that ‘T’= 2 years. Hence, this becomes the
time-partition.
2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

Rates before ‘T’ are:
g1= Dt – Dg = Rs 2 – Rs 0.75
= 167%
D0 Rs 0.75

g2 = D2 – D1 = Rs 3.00 – Rs 2.00
= 50%
D1 Rs 2

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

• The values VT(1) + VT(2) can be calculated as follows:

VT(1) = Rs 2.0 + Rs 3.0

= Rs 4.35
2
(1+0.15) (1+0.15)²

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

VT(2) = Rs 54-4.35 = Rs 49.65

Since VT(0) = VT(1) + VT(2) the two values can be summed to find
the intrinsic value of a equity share time ‘zero’

V0 = Rs 4.01 + Rs 49.91 = Rs 53.97

At the current price of Rs 54.00, the share is fairly priced and

hence you may or may not trade.
2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

 Categories of Bonds

• 1. Bonds with Maturity

• 2. Pure Discount Bonds
• 3. Perpetual Bonds

Dr. Shahrukh Saleem, VITBS,VIT, Vellore 2/9/2024

 Value of Bond with Maturity

• Yield-to-Maturity
• Current Yield
• Yield-to-Call

Dr. Shahrukh Saleem, VITBS,VIT, Vellore 2/9/2024

 Illustration

• Arun Ltd Proposes to sell ten-year debentures of Rs. 10,000 each. The
Company would repay Rs, 1,000 at the end of every year and will pay
interest annually at 15% on the Outstanding amount. Determine the
present value of the debenture issue if the capitalization rate is 16%.

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore

Year Interest Repayment Cash flow (4)= (2)+(3) PV factor 16% Present Value 16%
(1) 15% (3) (5) (6)=(4)*(5)
(2)
1 1500 1000 2500 0.862 2155.00
2 1350 1000 2350 0.743 1746.05
3 1200 1000 2200 0.641 1410.20
4 1050 1000 2050 0.552 1131.60
5 900 1000 1900 0.476 904.40
6 750 1000 1750 0.410 717.50
7 600 1000 1600 0.354 566.40
8 450 1000 1450 0.305 442.25
9 300 1000 1300 0.263 341.90
10 150 1000 1150 0.227 261.05
Present Value of 9676.35
Debenture

Dr. Shahrukh Saleem, VITBS,VIT, Vellore 2/9/2024

 Illustration

• A Rs. 100 Perpetual Bond is currently selling for Rs 95. The Coupon Rate
of Interest is 13.5% and the appropriate discount rate is 15%. Calculate the
value of the Bond? Should you buy the bond? What is its YTM?

Dr. Shahrukh Saleem, VITBS,VIT, Vellore 2/9/2024

Value of the Bond= Interest/ kd
= 13.5/ 0.15= Rs 90
At Rs. 95 the Bond is over valued, Hence one should not buy the bond.
Yield to Maturity (Y-T-M) = Interest/ Current value of the bond
= 13.5/ 95
= 0.142 or 14.2%

Dr. Shahrukh Saleem, VITBS,VIT, Vellore 2/9/2024

 Thank you

2/9/2024

Dr. Shahrukh Saleem, VITBS,VIT, Vellore